Escaping the Great Recession

High uncertainty is an inherent implication of the zero lower bound, while deflation is not because of inflationary pressure due to uncertainty about how debt will be stabilized. We show that policy uncertainty empirically accounts for the absence of deflation in the US economy. Announcing fiscal austerity is detrimental in the short run, but it preserves macroeconomic stability. On the other hand, a recession can be mitigated by abandoning fiscal discipline, at the cost of increasing macroeconomic instability. The policy trade-off can be resolved by committing to inflating away only the portion of debt accumulated during the recession.